Having a background in sociology, philosophy, and economics, I'm going to try to give this blog a pretty broad scope. Going from finance and economics, to geopolitics and world news, to the occasional academic or theoretical post.
I was born in Buenos Aires, Argentina and live in New York, so we'll try to add that into it as well.
Even though I like Adam Smith, don't be surprised if a little Marx makes its way in there as well.
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Five years after the worst financial crisis since the Great Depression, the outlook for U.S. banks is finally improving, according to Moody’s, which upgraded their view on the financial system from negative to steady on Tuesday. Wall Street has thrived on Ben Bernanke’s ultra-low interest rates, allowing major banks to strengthen their balance sheets and benefit from an improving economy. But easy money is a double-edged sword, eroding profitability by reducing net interest margins, and, more dangerously, encouraging looser underwriting standards, which appear as the greatest medium-to-long-term risk for banks going forward.

Wall Street is smiling. Stock markets continued to smash records, the housing market is coming back, and consumer confidence is at multi-year highs. Banks, which were at the center of the financial crisis and ultimately got bailed out by the federal government, spent the past several years digesting their toxic portfolios, rebuilding balance sheet strength. And according to Moody’s, they are finally there.

“Continued improvement in [banks’] operating environment and reduced downside risks […] from a faltering economy,” have led the credit rating agency to lift their outlook on the industry to stable for the first time since 2008.

As with most things in the market these days, it’s all about the Fed. “The low interest rate environment is the single most important issue that will drive U.S. banks’ performance in the next 12-18 months,” analysts at Moody’s explained.

Consistent monetary stimulus from the Bernanke Fed and the pledge to keep rates at the zero bound several years out has boosted private-sector hiring, offsetting government job losses. Moody’s expects the U.S. economy to expand at a rate of 1.5% to 2.5% this year and next, while unemployment should continue to decline to ward 7%. This has supported banks’ efforts to clean up their balance sheet and improve asset quality, with net charge-offs approaching pre-crisis levels.

Banks have been concentrated in reducing credit-related costs and restoring capital, better positioning themselves to face any future economic downturn, and markets have rewarded them for it. This year, major names like Citigroup, Morgan Stanley, Goldman Sachs, JPMorgan Chase, and Wells Fargo have all outperformed the S&P500 (only Bank of AmericaBank of America lagged); and over the past five years, a few of the largest players have managed to surge past their 2008 values.

And while banks have basked in the comfort of Bernanke’s unprecedented flood of liquidity, low rates also pose great dangers for Wall Street. Beyond the oft-cited reduction in net interest margins (when the Fed flattens out the yield curve, it becomes more difficult for banks to make a difference from borrowing short and lending long), low rates push financial institutions to look for alternative ways to make returns.

Thus, banks looking for higher yields delve into riskier assets, which ultimately means looser loan underwriting standards. This, in great part, is what led to the financial crisis, as banks used derivatives tied to the residential real estate market and increasingly targeted borrowers with lower credit scores. In the medium-term, this generates greater credit costs and, in an extreme situation, collapses the financial system.

In their report, Moody’s acknowledged that banks are healthier but face the same type of risk that led them to the abyss in the first place. “The most likely scenario that could result in a reversion to a negative outlook on the U.S. banking system would be related to a protracted slackening of underwriting standards,” they concluded. For now, though, it’s time to keep the Champagne flowing.

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